Introduction to Options and Futures (30150)
Problem set 6
These questions will help you practice the material we covered in our topic 3.1 “Options –
Introduction & arbitrage”. The relevant theory, and most of the problems, are from of Hull
(2012).
1. An investor sells a European call option with strike price of K and maturity T and buys
a put with the same strike price and maturity. Describe the investor’s position.
2. Suppose that a European put option to sell a share for $60 costs $8 and is held until
maturity. Under what circumstances will the seller of the option (the party with the short
position) make a profit? Under what circumstances will the option be exercised?
3. The price of a non-dividend paying stock is $19 and the price of a three-month European
call option on the stock with a strike price of $20 is $1. The risk-free rate is 4% per annum.
What is the price of a three-month European put option with a strike price of $20?
4. A four-month European call option on a dividend-paying stock is currently selling for $5.
The stock price is $64, the strike price is $60, and a dividend of $0.80 is expected in one
month. The risk-free interest rate is 12% per annum for all maturities. What opportunities
are there for an arbitrageur?
5. We have proved in class that 𝑝 ≥ 𝐾𝑒 −𝑟𝑇 − 𝑆0 . Use put-call parity to state an alternative
proof of this result.
6. The price of a European call that expires in six months and has a strike price of $30 is $2.
The underlying stock price is $29, and a dividend of $0.50 is expected in two months and
again in five months. Interest rates (all maturities) are 10%. What is the price of a European
put option that expires in six months and has a strike price of $30?
7. Explain the arbitrage opportunities in Problem 6 if the European put price is $3.
8. Assume that the underlying does not pay a dividend. As in the textbook, let 𝑐 and 𝑝
denote European call and put option prices, and 𝐶 and 𝑃 American call and put option
prices. Prove that:
𝑆0 − 𝐾 ≤ 𝐶 − 𝑃 ≤ 𝑆0 − 𝐾𝑒 −𝑟𝑇
[Hint: For the first part of the relationship, consider (a) a portfolio consisting of a European call plus
an amount of cash equal to 𝐾, and (b) a portfolio consisting of an American put option plus one
share.]
9. As in the textbook, let 𝑐 and 𝑝 denote European call and put option prices, and 𝐶 and 𝑃
American call and put option prices. Denote by 𝐷 the present value of all dividends on the
underlying. Prove that:
𝑆0 − 𝐷 − 𝐾 ≤ 𝐶 − 𝑃 ≤ 𝑆0 − 𝐾𝑒 −𝑟𝑇
[Hint: For the first part of the relationship, consider (a) a portfolio consisting of a European call plus
an amount of cash equal to 𝐷 + 𝐾, and (b) a portfolio consisting of an American put option plus one
share.]
10. Call options on a stock are available with strike prices of $15, $17.5, and $20 and
expiration dates in three months. Their prices are $4, $2, and $0.5 respectively. Explain how
the options can be used to create a butterfly spread. Construct a table showing how profit
varies with stock price for the butterfly spread.
11. Use the put-call parity to relate the initial investment for a bull spread created using calls
to the initial investment for a bull spread created using puts.
12. How can a forward contract on a stock with a particular delivery price and delivery date
be created from options?